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Investment in Russia: Super Power Opportunities

The Russian power sector is priming itself for outside financial and infrastructure investment. By Branko Terzic and James Balaschak
Fortnightly Magazine - February 1 2003

power consumption growth in Russia will be materially lower than world average, while under the favorable scenario, growth will be at the average world level.

The expected growth in power consumption until 2020 and the high levels of power generating capacity retirement expected during the period will require significant construction of generating capacity to compensate. The forecasted levels of generating capacity retirement due to physical obsolescence are illustrated in Figure 5, P. 30.

By 2020 the total retirement of generating capacity will exceed 163 million kW, or about 75 percent of the installed capacities as of January 2001. The level of new capacity needed to compensate for the retirement of equipment and to meet the growing demand is illustrated in Figure 6.

Total construction of generating capacity during the period 2001 to 2020 is estimated to be 231 million kW.

Figure 7 shows the estimated investment needed to realize the forecast (including new transmission lines and heating network) corresponding to the "reduced" scenario of Russia's economic development.

Under the "favorable" scenario of economic development, the necessary investment in the power sector would increase to $271 billion over 20 years.

There are limited possibilities to raise such a large investment either internally through companies operating in the industry (primarily RAO UES and its subsidiaries), or through special financing from the state budget of the Russian Federation. In the 1990s, due to privatization of the industry (excluding the nuclear power sector), capital investment from the state budget virtually ceased to exist. Financing through power companies' own funds accounted for no more that one-tenth of the estimated investment needed.

The legislative package being reviewed by the Duma during early 2003 contains all the essential elements necessary to begin the transformation process for the Russian power sector. This includes a new regulatory law, which clearly establishesregulatory principles and grants federal regulators the necessary authority to be able to assure investors and Russian consumers of fair treatment.

Russian regulators have recognized the need to introduce regulatory schemes that treat both consumers and investors fairly. An April 2, 2002, document (No. 226) titled "Foundations of Price Formation" embodies attractive and workable cost-of-service type pricing methodology for electric tariff setting. This document follows long-established and proven U.S. regulatory practices of regulation to provide for recovery of reasonable costs of service, including recognition of fair return on current investment at rates determined by capital markets. These kinds of principles in the hands of regulators newly empowered by the proposed electricity bill will create the opportunity for a very attractive investment environment in Russia.

International investors and Russia's domestic investors will be offered significant opportunities for large-scale private investment in the Russian electric power industry over the next four to five years; in addition, some opportunities for financing independent power projects are already available and required to meet near-term needs. There is every expectation that some workable version of the currently proposed legislation will be successfully implemented into law by the Duma and thus create the conditions for an electric industry capable of supporting Russia's vast potential for economic growth in